By Ann Cavoukian Ph.D. and George Tomko Ph.D.
In a few of our previous articles, we commented on the expansion of the money supply and its dire effects on freedom and privacy. Namely, that the expansion of the money supply, that is not tied to a concomitant generation of wealth, is one of the greatest threats to our liberty. We only have to point to the Weimer Republic, Argentina, Venezuela and so on, where high inflation resulting from artificial money supply expansion, led not only to greater poverty for workers but also indirectly to the loss of their freedoms. What we will try to do in this article is outline the connection in as simple terms as we can, along with the necessary background. We will use the US as a model since it is obviously the “elephant in the room.”
The Background
In economic terms, the total wealth of an organization is generally measured by the present value of its assets (its capital value), plus its current income. The stakeholders of a private corporation, for example, want to maximize total wealth, and as good stewards, they would not sacrifice the present value of their assets for increases in current income unless there is an aggregate increase in total wealth. Therefore, planning horizons are far longer than the current fiscal year. A private corporation, for example, will not (or at least should not) take on huge debt, payable in the future, knowing that it will not be able to service that debt, or pay off the principal when it is due.
In contrast, politicians largely focus on the current use of government resources, not their capital value. Their planning horizon is short – normally the next election cycle. Elected politicians have little concerns about the future, realizing that they may no longer be in power. With only a few exceptions of note, government spending has always exceeded tax revenues. And over generations of election cycles, we have seen a massive buildup of long-term debt, regardless of the political party in power, and a boondoggle of projects where vast sums of taxpayers’ money has been wasted. Politicians love to call them “investments,” but in so doing, have turned the term into a euphemism. They finance their spending by increasing taxes, and printing money via issuing debt instruments to cover the shortfall. And the purpose of the spending is redistribution, military might, or some other ideological causes — but ultimately, in order to be re-elected and retain power.
In the US since 2010, the measure of the quantity of money (M2 plus Currency and Credit derivatives) increased from $94 trillion to currently $635 trillion, namely a 575% increase in the money supply. In contrast, during the same time frame, US Gross Domestic Product (GDP) only increased from $10.23 trillion to $24.1 trillion, an increase of 135%. The money supply increased by more than 4 times the GDP! So far, much of that “inflationary money” has gone into the stock market and not the Consumer Price Index (CPI). Using the Dow Industrials as a proxy, it climbed from 9,835 in 2010 to a high of 36,950 this past January, 2022, or 275% — an absolute increase of 140% over the GDP’s increase of 135%! However, conditions are changing.
First, to understand the reason why money is being “printed,” we must dig deeper. In the US, the total Federal spending is approximately $6.8 trillion (of which the largest spending items are Medicare/Medicaid – $1.3T, Social Security – $1.1T, Defense/War – $723B, and interest on the national debt of $30T – $429B). But, the Feds only collect $4.1 trillion in tax revenues, a deficit of $2.7 trillion — and to cover the deficit, debt instruments are issued. On top of that, current total unfunded liabilities stand at $168 trillion. These are US liabilities for future payments of Social Security, Medicare, pensions and the like, which are not covered by any assets, collateral, or future revenue streams. This is based on the number of people currently living that will collect these benefits, and their actuarial estimated life-span. In order not to default on these payments, the money supply will have to be expanded even more.
In contrast, while the US National debt increased by 125% to $30T from 2010 to the end of 2021, the Canadian National Debt increased by 150% to $1.19T during the same time period. Per capita, Canada is now approaching the debt of the US.
As a result, in the US the average cost of a home, which in 1930 was $3,845 compared to the average wage of $1,970 (a relative factor of 1.95 or nearly 2 years of wages to pay off a home), has shot up dramatically — such that in 2018 it was $385,880 and $52,145 respectively (or nearly 7.5 years of wages to pay off a home). The same historical trends are there for cars, fuel, bread, meat and so on — except for electronics, where free market competition with minimal regulations and maximal asymmetry of information, overcame the devaluing of the fiat currency. The significance of asymmetry will be discussed later in this article.
What is Inflation?
Fiat currency is regulated by governments, specifically in conjunction with Central Banks where they have a symbiotic, nepotistic relationship. The expansion of the money supply by the Central Bank (literally printing it by purchasing treasury bonds), in concert with the Fractional Reserve loans made by commercial banks, generates the inflation which devalues the money in your pocket.
Few may realize that the banking fractional reserve system is the major cause of expansion of the money supply. If you were to borrow $100 from a colleague, your account would be credited with that $100, and conversely, your colleague’s would be debited — in other words, they would have $100 less to spend. On the other hand, if you were to borrow $100 from a commercial bank, your account would also be credited with $100, but there would be no comparable debit on the bank’s books. In a fractional reserve system, where the “multiplier” is 20 times for example, for every $100 that people deposit into their savings, the bank can loan out 20 times $100. The money is literally created “out of thin air.” It is the interest rate that regulates demand for loans. The higher the rate, the fewer the number of loans demanded. But also when a loan “turns over,” it is always at the prevailing rate, depending on one’s risk category, therefore as rates increase, the servicing of debt increases — which will have consequential outcomes.
Inflation is not an increase in price due to an increase in demand, where there is no offsetting increase in supply. Many conflate normal supply-demand economics with inflation. Inflation is specifically an artificial increase in the money supply without a concomitant increase in supply. For example, if one were to create an artificial economy with 100 units of a product, in conjunction with $100 circulating in the economy (assuming no hoarders), eventually each product would equilibrate to $1 each. If one were to add an additional $100 to circulate in the economy without a concomitant increase in units of the product, each product would equilibrate to $2 each. That is the cause of inflation — fewer goods chasing more money! Other factors are also involved, such as the velocity of money (transactions), but that will determine how rapidly the additional $100 circulates and equilibrates.
In our artificial economy, if the units were barrels of oil, by expanding the amount of money two-fold, the doubling of the price of oil would be due to inflation. However, if the money supply was kept constant and the supply of oil was halved while maintaining demand, then the doubling of the price would be normal supply-demand economics — not inflation. Similarly, if the supply was doubled, then the price would be halved. Many would incorrectly classify that as deflation, but again, it would be normal supply-demand behavior. Inflation and deflation are both a function of money supply. In an integrated economy there are many other complicating factors, but what we want to make clear is that inflation results from money that is created, chasing fewer goods.
Asymmetry to the Rescue
All economic transactions are asymmetric, meaning that if I purchase a product or service for $20, I value the product/service more than my $20, whereas it is the converse for the vendor. Asymmetry of values drives our economic system, for without those asymmetries there would be no transactions and therefore no market system. Not only are there asymmetries in assessment of value, but also the information underlying the reason for the transaction. That is why I can purchase a share of IBM, for example, at $130 — because of asymmetry of information. Ignoring dividends, my information tells me it may rise in price; in contrast, the seller thinks it may not rise in price, possibly even fall. The entire market system is dynamic and works because of asymmetrical information.
Asymmetry of information1 also drives discovery. It is the basis of innovation — if there were to be equality of information across society (which in real life would be impossible), there would be no market, no motivation to discover something new. Many call this market competition, but again, it really is a drive to increase asymmetry of information by gaining knowledge. In effect, an epistemological exercise that benefits all, since in a market system, knowledge can only benefit the discoverer if it is distributed somehow to customers.
On the other hand, regulations, beyond protecting property and contracts, are an attempt to reduce asymmetry of information, in order to establish a “level epistemological playing field” — which never works. Its goal in social justice terms is equality, but it results in an inhibition of the discovery process. Regulations ultimately favor established corporations or those with preferred ideological missions — at the expense of entrepreneurial start-ups that have their own “skin-in-the-game.”
Regulations increase the price of a product relative to its value. They add administrative costs, which must be included in the price. For any start-up with initially a limited capital base, administrative costs to satisfy regulations always detract from R&D and marketing. They are at a disadvantage to established, larger companies which can spread out these costs over many more units of the product, or to subsidized start-ups. In addition, the less funding available for R&D, the less asymmetry of information and innovation.
And now, because all economic sectors are heavily regulated, which dampens free market competition and reduces asymmetries, it will be extremely difficult for any sector to overcome money devaluation as did the electronics sector in previous decades — where a computer the size of a bedroom costing $millions was shrunk to a hand-held marvel costing only $hundreds!
The Government’s Chickens Come Home to Roost!
Politicians are now in a bind: they cannot tax their way out of debt, even if they were to confiscate all the wealth from the “rich” people — even if the 400 plus billionaires in the US had their entire wealth confiscated through taxes, that would only provide a one-time revenue bump of approximately $5T (not to mention what a massive blow this would be to their freedom, and property rights). In addition, the demand for more “free stuff” from government continues to escalate, which will increase debt even more, eventually ending in a major burst of the debt bubble (if interest rates were raised to counter inflation), and the ensuing dominoes effect resulting from the entangled global debt structure. If (some say, when) the debt bubble bursts, that will contract the money supply leading to deflation, followed by a recession, possibly depression. The recession will not arise because there is less money in the economy, but because supply and demand shrinks due to bankruptcies and increased unemployment, respectively.
And now the stock market appears to be topping, and we expect to see more of the “inflated currency” entering the domestic goods and services markets, increasing CPI inflation, as we are now observing. This will make workers relatively poorer by decreasing the value of their money — since wages are no longer keeping up. We say the market “appears to be topping.” In reality it is going to be a battle between innovation and the dire effects of an expanding money supply causing inflation, and innovation-reducing regulations which decreases informational asymmetry.
The only way that governments can finance deficits is by increasing taxes or by printing money — that is, by selling treasury bonds to Central Banks. Under the current economic conditions, increasing taxes won’t cover the deficits. But by continuing to print money, inflation will eventually go exponential. The conundrum that Central Banks face is that they cannot raise interest rates significantly to slow inflation for fear of increasing debt interest payments on the ballooning national debt, and also jeopardize the servicing of household and corporate debt in the private sector. Therefore, governments have a Hobson’s choice: on the fiscal side, cut spending dramatically, which no government can do and stay in power; or on the monetary side, continue to expand the money supply to offset shortfalls in revenues, which they will continue to do — until economic and social disaster befalls us.
However, there is potentially an even more egregious consequence of an expanded money supply — foreign-held US dollars reserves may be repatriated which will exacerbate inflation even more by devaluing the dollar!
In 2009, Ron Paul in a speech in the US Congress stated:
The economic law that honest exchange demands only things of real value as currency cannot be repealed. The chaos that one day will ensue from our experiment with worldwide fiat money will require a return to money of real value. We will know that day is approaching when oil-producing countries demand gold, or its equivalent, for their oil rather than dollars or euros.
As a result of invading the Ukraine, Russia has been removed from the US dollar system and much of its dollar reserves held by its Central bank have been seized. The reason that this will be devastating for Russia is that to date, countries can only sell and purchase oil with US dollars (Petrodollars).
This has been such an important geopolitical lever that the US indirectly threatens China with similar measures to ensure it didn’t invade Taiwan, or fully support North Korea (plus other things). As the worlds largest importer of energy, China needs dollar reserves to import oil and carry on trade, otherwise its economy would come to a halt.
In response however, China in conjunction with Russia have been creating an alternative to the petrodollar system which would allow oil be traded for gold and Bitcoin, and bypass the US dollar, financial system, and sanctions.
“The Shanghai International Energy Exchange (INE) launched a crude oil futures contract denominated in Chinese yuan in 2017. Since then, any oil producer can sell its oil for something besides US dollars… in this case, the Chinese yuan. There’s one big issue, though. Most oil producers don’t want to accumulate a large reserve of yuan, and China knows this. That’s why China has explicitly linked the crude futures contract with the ability to convert yuan into physical gold — without touching China’s official reserves—through gold exchanges in Shanghai (the world’s largest physical gold market) and Hong Kong. PetroChina and Sinopec, two Chinese oil companies, provide liquidity to the yuan crude futures by being big buyers. So, if any oil producer wants to sell their oil in yuan (and gold indirectly), there will always be a bid.
Russia is the world’s largest energy producer. China is the world’s largest energy importer, and Russia is Beijing’s largest oil supplier. And now that the US has banned Russia from the dollar system, they have an urgent need for a credible system capable of handling hundreds of billions worth of oil sales outside of the US dollar and financial system.
Other countries on Washington’s naughty list are enthusiastically signing up. For example, Iran—another major oil producer—accepts yuan as payment. So do Venezuela, Nigeria, and others.”
If this is the beginning of the end of the dollar hegemony, many countries will not require maintaining US dollar reserves in order to purchase energy. The fact of the existence of a gold-backed currency will change the global financial landscape. No longer will the US be able to increase its money supply and export these dollars to foreigners, thus shielding their political derrières from rampant domestic inflation. But if the Chinese are true to their word in their promise to convert the yuan to gold (yet to be demonstrated), then US dollar reserves will flood back home, and “Houston, we have a problem.”
To forestall economic disaster, governments will use a variety of authoritarian measures which will decrease our privacy and freedoms. As demonstrated in Canada, the freezing of bank accounts without a warrant, possibly a tax on net worth over a certain value, and greater surveillance to determine who has what, laws to prevent protesting, and even measures that have not yet been contemplated will be enacted. On our current economic trajectory, people will not only have their freedoms diminished, but also their financial well-being — especially for those on government benefits. That would be tragic since a large number of innocent families would be devastated if governments “ran out of money,” or the money became so devalued it could purchase far less. Governments have made a mess and the numbers don’t lie. Mainstream media, outside of a few reputable financial news organizations, will not report this, they will probably just claim that it is “fake news.” So what do we do? Do we just throw up our hands, and give up? Never!
The Road Less Travelled
Governments have three options:
- Raise interests rates sufficiently to stop inflation, which would crater the stock and bond markets with an almost guaranteed ensuing recession, possibly even a depression;
- Don’t raise interest rate significantly — continue to expand the money supply and crater the dollar.
With option 1 or 2, the result will be societal unrest; and to maintain control and power, governments will introduce even more surveillance and place more restrictions upon our freedoms and privacy. This is not a novel script! It has been played out many times over the last century, but this time it may very well reach the “top of the hit parade!” We must replace the coercive, immoral aspects of political democracy with true freedom, that is economic democracy. We must strive for option 3 below: - Emulate the electronics sector of past decades across the entire commercial spectrum — remove all unnecessary regulations other than those that protect property and contracts. Open up all sectors to innovators. Remove all subsidies to industry and let asymmetry reign! Governments must get out of the business of trying to pick winners — they’re lousy at it!
What we would notice is a tremendous increase in economic prosperity — more jobs, with fewer requiring government benefits, and those that did, would be covered by the increases in tax revenue. Also, true free markets and the accompanying innovation would lead to decreasing prices, which would partially offset money supply expansion.
The choice we now face is either free markets or cultural and economic calamity — there is no other choice. If politicians really care about people (and not just giving just lip-service to caring), they could do this almost immediately. We will go far out on a limb and say this may be the only way — only freedom and innovation will be our true savior!
However, one of the criticisms of free markets is that informational asymmetry between buyers and sellers, gives the latter an advantage of greater information, especially if they are not willing to share it. Yes, sellers as producers of the product, sometimes do have an information advantage. However, the free market has also provided a resolution to this issue with a number of innovations such as warranties, franchises, and so forth, which Richard Ebeling has documented in a cogent and readable article. In effect by paying a small amount, a warranty protects the value of your purchase for the lifetime of the warranty. So, in many cases, I can purchase a warranty, or even insurance, to protect the value of my purchase or property.
Dr. Ann Cavoukian is a member of our Board of Directors for the Probe Foundation. Dr. Cavoukian is the Executive Director of the Privacy and Big Data Institute at Ryerson University. Recognized as one of the leading privacy experts in the world, Dr. Cavoukian is an avowed believer in the role that technology can play in protecting privacy. Her ground-breaking 1995 paper, Privacy-Enhancing Technologies: The Path to Anonymity, laid the foundation for her magnum opus, Privacy by Design (PbD) – which is now recognized as the world’s gold standard in privacy protection. Dr. Cavoukian is well known for her former role as Ontario’s longest serving Information and Privacy Commissioner.
Dr. George Tomko is a member of our Board of Directors for the Probe Foundation. He was recently appointed to the post of Expert-in-Residence in IPSI at the University of Toronto. Dr. Tomko is best known for having invented the privacy-enhancing technology called “Biometric Encryption,” as well as “Anonymous Database,” both of which were the subject of numerous patents in the 1990’s. Later he invented “SmartData,” and is presently working on developing Smart Intelligent Agents. Dr. Tomko served for three years as the Chairman of Photonics Research Ontario, one of four Ontario Centres of Excellence.